Schorsch Shakes Off Stock Decline With Biggest REIT DealBrian Louis
With about $5 billion in takeovers to complete and his company’s stock down more than 30 percent, Nicholas Schorsch had his hands full. That didn’t stop the chief executive officer of American Realty Capital Properties Inc. from making his biggest real estate bet.
American Realty agreed last month to buy Cole Real Estate Investments Inc. for almost $7 billion in a bid to become the largest owner of U.S. single-tenant buildings. The purchase, the country’s biggest of a real estate investment trust in two years, followed a failed attempt by New York-based American Realty to buy a Cole predecessor company just seven months ago.
The Oct. 23 announcement of the deal came as such a surprise that Daniel Altscher, an analyst at FBR Capital Markets, said he had to look at the press release multiple times to make sure he was reading it correctly. For Schorsch, it extends a buying spree that will triple American Realty’s portfolio of single-tenant, or net-lease, buildings, and comes at a time the REIT’s stock has fallen on concern that rising interest rates will increase costs and growth may be limited.
“He’s always said his goal was to become the largest net-lease REIT,” Mitchell Germain, an analyst with JMP Securities in New York, said in a telephone interview. “I don’t think anyone thought it was going to happen after six months.”
Schorsch’s company had about $15 billion in pending acquisitions at the end of last month, including Phoenix-based Cole, according to Bloomberg Industries. American Realty agreed in May to purchase CapLease Inc. for about $2 billion, and in July said it would acquire American Realty Capital Trust IV in a transaction it values at $3.1 billion. The deal for New York-based CapLease is scheduled to be completed this week.
Those transactions follow the purchase of American Realty Capital Trust III Inc. in February for more than $2 billion in cash and stock. That company, like ARCT IV, was a nontraded REIT formed under AR Capital LLC, which is led by Schorsch.
AR Capital is the largest fundraiser for nonlisted REITs, which don’t trade shares on stock exchanges and mainly attract money from individual investors. Schorsch helped build his fortune leading that firm and he’s currently chairman of at least 10 companies that are part of or were spawned from it.
American Realty, which was formed out of AR Capital and went public in 2011, will have a projected enterprise value of about $22 billion after the pending deals close, compared with $135 million two years ago. The REIT probably is done with major purchases, at least until the current ones are completed, Schorsch said in an interview.
“We’re taking a break,” he said. “We’re going to finish what we started. Execute deliberately and prudently and then we’ll see what’s next.”
The proposed deal for Cole is the biggest acquisition of a U.S. REIT since AMB Property Corp. bought Prologis for $16.5 billion in 2011, data compiled by Bloomberg show. The combined company will have 3,732 properties in 49 states and Puerto Rico, according to the Oct. 23 statement. Along with the CapLease and ARCT IV deals, American Realty’s portfolio will have increased from about 1,180 buildings in June.
The largest U.S. single-tenant REIT is currently Escondido, California-based Realty Income Corp., which has more than 3,800 properties. Its enterprise value was about $13 billion in the third quarter, Bloomberg data show.
In March, American Realty tried to buy Cole Credit Property Trust III, then a nontraded REIT, in a deal valued at about $5.7 billion at the time. American Realty claimed that a plan by Cole to buy its sponsor and go public was enriching management at the expense of shareholders. Cole, which said the bid undervalued the company and would have required an unsustainable level of debt, proceeded with its purchase and listed its shares in June.
A tie-up between the companies after their hostile clash was surprising for most people, “definitely for me,” said FBR’s Altscher, based in Arlington, Virginia. Cole’s acquisition just months after going public was “shocking,” he said.
American Realty is paying more for Cole now, Simon Yarmak, an analyst at Stifel Nicolaus & Co., wrote in a report. He estimated that the deal is 7.4 percent higher than the previous offer.
Schorsch said American Realty is paying 3 percent or 4 percent more. The price is higher now because it is a friendly deal and Cole is a public company with more transparency, he said.
The acquisitions of Cole and ARCT IV are being funded through cash and stock, with perpetual securities added to the ARCT IV deal after a plunge in American Realty’s share price forced the company to adjust the terms. The stock fell as much as 32 percent from a May high as part of a rout in single-tenant landlords on the prospect of rising interest rates.
Net-lease companies, whose tenants range from drugstore chains to restaurants, make money on the spread between their cost of borrowing and the yield, or capitalization rate, on the property they buy, making them sensitive to increases in interest rates, said Paul Adornato, an analyst at BMO Capital Markets in New York.
“The whole business model depends on getting accretion from acquisitions,” Adornato said. “If there’s a rise in interest rates, stocks could be expected to decrease, therefore the deal economics could become less favorable.”
Shares of American Realty have climbed 8.9 percent from the low for the year set on Sept. 30, and are little changed since the Cole deal was announced.
American Realty is getting $2.75 billion of financing from Barclays Plc for the Cole purchase. Shareholder value won’t be reduced because of the added revenue from Cole properties and the estimated $70 million of savings in the first year, Schorsch said.
“It’s definitely not dilutive,” Schorsch said. “We’re picking up so much revenue.”
American Realty said the Cole deal, scheduled to close in the first half of 2014, will lower its ratio of net debt to earnings before interest, taxes, depreciation and amortization to 7.7 from 9.1 by the end of the year. The transaction will help offset the debt load that was anticipated to increase with the acquisitions of CapLease and ARCT IV, Yarmak of Stifel wrote.
“It de-levers us massively,” Schorsch said.
American Realty’s newly enlarged portfolio could make external growth harder, Michael Gorman and Timothy Feron, analysts at Janney Capital Markets, wrote in an Oct. 23 report. The REIT expects to make $2 billion of property purchases next year, according to an investor presentation.
Any benefits of the Cole purchase may be countered by “substantial equity overhang” tied to the complexities of integrating multiple transactions that will be completed in the next two to three quarters, they wrote. The analysts maintained their neutral rating on the company.
“It’s created a lot of moving parts in the story,” Gorman said in a telephone interview. “As that settles out, you could see some improvement in their relative valuation, but it remains to be seen.”
Integrating the acquisitions won’t be difficult, partly because there won’t be any mass layoffs and the people who manage the properties will work for the combined company, Schorsch said.
“It’s like buying a bond portfolio,” Schorsch said in a telephone interview. “It’s not complicated.”
American Realty’s acquisitions will make it the 14th-largest U.S. REIT by market value, which should boost liquidity and price support for investors and increase research coverage by analysts, according to the company’s investor presentation. Realty Income’s price relative to 2014 estimated funds from operations, a REIT measure of cash flow, is about 16 times, according to the average of 12 analyst FFO projections, while American Realty’s is 13 times, based on four analysts.
“At the end of the day it’s trying to get a higher multiple,” said Jeffrey Langbaum, a senior analyst with Bloomberg Industries. Schorsch is “trying to set himself up as one of those major players in the REIT space.”